Damages in Construction Arbitrations

Introduction

Damages in construction disputes can arise from many different project-specific circumstances, with the type of damage suffered and the method of quantification dependent on, among other things, the discrete facts of the case, the governing law, the form of contract and the available evidence.

However, the prevalence of certain events and circumstances in international construction projects, such as changes to the work, project delay, instructions to expedite performance (acceleration), the effects of reduced productivity (disruption) or the consequence of termination is likely to cause both contractors and employers to incur additional costs and thus give rise to several common heads of claim for construction damages.

Although these claims may sometimes be assessed cumulatively with reference to the total cost method, for example, it is widely accepted that, where possible, the damage should be quantified discretely with a causal nexus between the event and the damage established.

The purpose of this chapter is to provide the reader with an overview of the types of damages common to international construction arbitration and the methods of quantification that may be adopted by the parties to the arbitration. This chapter does not address the concept of indirect or consequential loss, which contractors may also experience as a result of these or similar events.

Global claims

Although the specific quantification methods may vary, a global claim – as the name suggests – exists when a contractor asserts that its global or total loss was the result of an employer-responsible event, or events, or other causes without attributing that loss to each discrete event or cause. In base terms, a contractor may seek to deduct its tender sum from its total actual cost and claim the difference.

Liability issues aside, this method has often been criticised for failing to account for tender errors and underbids that may have reduced the contractor’s tender, as well as cost overruns caused by the contractor that may have inflated the actual cost, the effect of which results in an overstated total cost claim.

A more accurate alternative is the modified total cost approach. This approach is still predicated on a ‘top-down’ assessment in which the starting point is the full and total cost incurred, but the approach is modified to exclude items of cost that can be identified and attributed to contractor-caused events, such as contractor inefficiencies and variations.

Although the modified total cost approach has been accepted by some courts and tribunals, it is unlikely to be persuasive unless the contractor can demonstrate that the causes are so intertwined or pervasive that they are unable to be separated and discretely quantified.

Additionally, the contractor must demonstrate that its tender was both realistic and reasonable, that its actual costs were reasonably incurred and that it was not responsible for the overspend.

Delay costs

Delay-related costs are the damages or compensation awarded to an injured party in the event of a delay on a construction project. All construction projects will be governed by some form of contract that will invariably provide a time frame for completion of the project. When completion of the project is delayed, both principal parties to the contract suffer.

A critical factor in the calculation of damages is the assignment of liability for the delays suffered. In the event of contractor-caused delay, most standard form construction contracts contain provisions for liquidated damages as the exclusive damages remedy to the employer. Liquidated damages are a genuine pre-estimate of the loss that is likely to be suffered if the project is delayed. Liquidated damages are typically capped at a percentage of the contract price, commonly 10 per cent.

In some Middle East jurisdictions, the law may also permit a tribunal to award general damages to an employer in addition to the liquidated damages prescribed by the contract. For example, contracts with public bodies in Dubai in the United Arab Emirates (such as the Roads and Transports Authority, or the Dubai Health Authority) are subject to the supervening laws of Dubai. Law 12 of 2020, which governs the procurement of goods and services by public bodies, provides that if the damage suffered as the result of a breach are greater than the limit under the contract, the court can award general damages over and above, and in addition to, the liquidated damages prescribed in the contract.

An award of general damages is more commonly made in favour of the contractor. The award is then predicated on a finding by the tribunal of an employer-caused critical delay. In these circumstances, a contractor will be entitled to a compensable extension of time award. The temporal finding will provide the framework for the calculation of damages (i.e., it is necessary to first calculate the period of compensable delay before the corresponding compensation can be calculated).

Not all extension of time awards will result in an award of damages. It is not uncommon that both principal parties will share responsibility for the delay (in part or in whole). In these circumstances a tribunal may award an extension of time without damages (i.e., a non-compensable award).

Although the contractor will not be compensated for the prolonged period of work, it will not suffer a greater loss by the levy of liquidated damages. Similarly, the employer will not receive the benefit of damages for the delay for which it was responsible.

In the circumstances of an employer-caused critical delay, the damages assessment represents the financial accompaniment to the extension of time. Colloquially referred to as a ‘prolongation claim’, it is the damages awarded to the contractor for its prolonged engagement in the performance of the work. The calculation of delay-related damages in construction follow the ordinary common law principles of damages: to provide compensation to place the injured party back in the position it would have been in but for the matter relied on. However, an injured party is not entitled to unfettered damages in compensation.

The calculation of the compensation to be awarded is subject to the following considerations:

  • Is the cost claimable under the contract or governing law (or both)?
  • Over what period is the cost compensable?
  • Is the cost claimed reasonable?
  • Has the cost been incurred, or does a bona fide cost liability exist?
  • Has the cost been recorded in the correct period?

In the practical application of this principle, a compensatory award will entitle the contractor to recover its actual time-related costs demonstrably incurred during the period of compensable delay that flow from the breach and are reasonable in the circumstances. For a contractor to have a reasonable chance of succeeding in a claim for delay-related damages, the damages assessment should follow these general principles and guidelines:

  • It should be based on actual time-related costs incurred during the period of critical compensable delay.
  • It should be supported by source accounting data extracted from independently audited accounts.
  • It should consider only time-related, indirect resources that are attributable to the matter relied on, excluding any costs that would have been incurred in any event.
  • It should exclude all direct costs of carrying out the work.
  • It should be assessed at the time the delay affects the project.

Typically, a claim for delay-related damages in a construction contract would include the following broad categories of time-related costs:

  • running costs of the site set-up, including: rental of office and mess facilities; power and water; land rental; security services; and any other costs incurred to maintain the contractor’s site set-up;
  • staff costs pertaining to those who typically perform a supervisory or management function of the works;
  • plant or machinery that is hired to perform a site-wide function (excluding plant hired in the direct performance of the work, which would be recovered via the contract rates and prices); and
  • insurances, bonds, bank guarantees, and any financial instruments prolonged as a result of the delay.

The above categories of costs are not intended to be exhaustive. They provide only a sample of the categories of time-related costs that may be considered by contractors and employers when assessing the costs associated with a claim for delay. A crucial factor in the calculation of delay-related damages is to distinguish actual costs from any tender or contract allowance.

A contractor’s actual time-related costs will have no intrinsic relationship to the contract price; the aim of a damages award is to neutralise the harm suffered and return the contractor to the position in which it would otherwise have been. If the calculation of that award was constrained by the contract price (i.e., referable to what is commonly termed the ‘preliminaries’ element of a contract price), the award may be inadequate compensation for the harm suffered.

Disruption costs

Keating on Construction Contracts provides that: ‘Disruption occurs where there is a disturbance of the contractor’s regular and economic progress and/or delay to a non-critical activity even though, on occasion, there is no or only a small ultimate delay in completion.’[2]

Similarly, the Society of Construction Law (SCL) Delay and Disruption Protocol provides the following definition: ‘Disruption (as distinct from delay) is a disturbance, hindrance or interruption to a Contractor’s normal working methods, resulting in lower efficiency.’[3]

Disruption is thus any change, or changes, in circumstances, sequence or working methods that prevents the contractor from achieving the level of output that it had anticipated.

The damage manifests itself as reduced productivity of a project resource, which results in the application of more resources than planned, at a greater cost.

Productivity is the rate of output per unit of input. In construction, output may be the achievement of an element of work, such as a cubic metre (m3) of concrete poured, a tonne of steel work erected or a metre of cable pulled, and the input is the effort (often expressed in hours of labour or plant) required to achieve the output.

To the extent that it can be established that the employer was responsible for a change to the conditions that negatively affected its productivity, there are several methods available to the contractor for quantifying its disruption damages. These methods can be broken down into two broad categories: cost-based and productivity-based.

Cost-based methods take the form of a global or total costs claim, as discussed earlier (i.e., the contractor asserts that all additional costs incurred beyond its plan were as a result of the employer-caused disruption).

As explained above, cost-based methods implicitly rely on the accuracy of the contractor’s original tender and the presumption that all matters giving rise to the loss of productivity are the responsibility of the employer.

Productivity-based methods are generally preferred and can be further subdivided into three categories:

  • project-specific methods (namely, the measured mile anaylsis);
  • industry studies; and
  • project comparison studies.

A productivity-based method, such as the measured mile approach, is preferred but its use is dependent on the availability of accurate and detailed resource and production records. In the absence of these records, a contractor may turn to comparative studies or total cost assessments.

A measured mile analysis is a comparison between the rate of productivity achieved on the project during an unaffected (or benchmark) period of work and the rate of productivity during a disrupted period. The difference between the two rates of productivity represents the effect of the change, which is usually reflected in hours per unit of output.

For example, a contractor was required to pour 1,500 cubic metres of concrete and was able to complete two-thirds of the work in unaffected conditions. However, the balance of the work was encumbered by employer-imposed access issues and restricted working hours, which disrupted its performance. An analysis of the rates of productivity identified that the contractor placed 0.87 cubic metres of concrete per hour during the benchmark period, which reduced to 0.5 cubic metres per hour during the disrupted period.

Concrete foundation workBenchmark periodDisrupted period
Output: Quantity of concrete poured (m3)1,000500
Concrete labour hours (hours)1,1501,000
Rate of productivity (m3/hr)0.870.50

The difference in productivity achieved between the benchmark and disrupted periods represents the loss of productivity suffered. In this example, the contractor suffered a 42.5 per cent loss of productivity. Thus, ‘but for’ the changes imposed by the employer, the contractor could have reasonably expected to complete the 500 cubic metres of concrete in 575 hours (500m3/0.87m3/hr) and, as such, suffered a loss of productivity of 425 hours.

 Productivity rateAmount
Output: Quantity of concrete poured (m3) 500
Concrete labour hours (hours): Disrupted period0.501,000
Concrete labour hours (hours): Benchmark period0.87575
Lost labour hours 425

The chief advantage of the measured mile approach is that it avoids any argument about the accuracy of the contractor’s tender because the productivity comparison is based on the actual productivity achieved. However, a measured mile assessment is not without its challenges:

  • Available data: the measured mile analysis requires accurate and complete resource and production records. If these records do not exist, a contractor may be forced to rely on an alternative method, such as industry studies and comparisons.
  • Lack of suitable benchmark: it may be difficult to identify a suitable baseline (i.e., a period of unaffected progress). In these circumstances, it is often preferable to find a period of minimal disruption. Alternatively, a contractor may consider the use of tender productivity or rates from analogous projects as a benchmark but would need first to establish that the rates applied are comparable, realistic and achievable.
  • Learning curve losses: reliance on the naturally lower productivity typically achieved during the early phases of the activities, as labour resources become accustomed to the method of working, may skew the benchmark.
  • Competing causes of disruption: care must be taken to account for the causes of disruption that are not attributable to the employer.
  • The unaffected period: the benchmark period must fairly represent the unaffected rate of productivity achieved by the contractor. Reliance on a brief or truncated period of work, during which the contractor achieved exceptional productivity, may artificially inflate the contractor’s loss.
  • Comparability of work: it is vital to ensure that the work carried out during the baseline and affected periods are of the same type and nature, performed under the same circumstances. For example, a comparison between the productivity achieved from pouring a ground-floor concrete slab with that achieved from pouring a cast in-situ flight of stairs would be of limited analytical value.

Industry studies provide the starkest instance of relying on an external source of data to demonstrate that a loss of productivity has been suffered and that an award of damages is appropriate. One such example of an industry study is that developed by the Mechanical Contractors Association of America, Inc (MCAA).

The MCAA developed a list of loss of productivity factors[4] to attempt to quantify the singular and collective effects of events commonly causing reduced productivity among mechanical contractors in the United States. First published in 1971, it is often relied on as an industry study and is used widely by claimants in the construction sector. The MCAA study provides 16 factors that can be used to evaluate the effect of an event on a contractor’s productivity, including:

  • trade stacking: between 10 per cent and 30 per cent, depending on the severity of the impact;
  • dilution of supervision: between 10 per cent and 25 per cent, depending on the severity of the impact; and
  • seasonal and weather changes: between 10 per cent and 30 per cent, depending on the severity of the impact.

The 16 factors in the MCAA study, including the three stated above, are generally accepted by industry practitioners as factors that have a negative effect on productivity in construction projects. The stacking of trades, where multiple competing trades are working simultaneously within a defined area of the site, will generally cause reduced productivity. Notwithstanding this, the percentages assigned by the MCAA to each of the factors lack provenance and are unlikely to be representative of the actual effect of any given disruptive event. A contractor seeking to rely on the MCAA factors must demonstrate that the work subject to its claim for loss of productivity damages is directly comparable to the MCAA work, and that there exists no better information on which to base an assessment of the loss suffered. These are typically difficult burdens to discharge. However, the MCAA factors remain a popular method for the assessment of loss of productivity owing to the simplicity of the application and the often-favourable analysis produced for the contractor.

Project comparison studies are generally accepted to provide a more robust basis to demonstrate loss of productivity when compared with industry studies. In simple terms, the project comparison method compares similar unaffected activities on different projects. For example, if a contractor was able to pour 100 cubic metres of concrete in a single day on Project A, but on Project B was able to pour only 80 cubic metres of concrete in a day, this may be indicative of a loss of productivity of 25 per cent. For such a comparison to be sustainable, it is vital that the two activities – the concrete pour on Project A and the concrete pour on Project B – are comparable. To the extent that the conditions differ significantly between the two projects, any comparison of productivity will be of limited value. For example, the 100 cubic metres achieved on Project A may have been at grade-level slab on an unobstructed site whereas on Project B, the 80 cubic metres may have been poured to a fifth-floor slab in a congested city centre location. Little can be drawn from a comparison of work carried out under such different circumstances.

In summary, productivity-based methods are preferable to both industry studies and project-comparison studies because they do not rely on any external sources or factors to demonstrate loss of productivity. Project-based methods use project-specific data from contemporaneous project records to demonstrate the loss of productivity suffered and the concomitant loss of productivity damages. Project-based methods of analysis include earned value analysis, system dynamics modelling and, more commonly, the measured mile analysis.

Head office overheads

Head office overheads are a recognised category of contractor cost relating to the running of its business and include costs of central services, office rents, head office staff, payroll, human resources and depreciation, among other things. The cost of a contractor’s head office is recovered through the project revenues generated by the contractor.

Although these costs can be quantified from a contractor’s financial statements and management accounts, they are rarely attributed to the specific projects and contracts and, therefore, are often allocated as a factor of project revenue.

When a contractor is unable to generate a contribution towards its head office overheads, it is often said that the head office overheads are unabsorbed. Claims for unabsorbed head office overhead costs arise when a contractor is unable to defray its head office costs because of a loss or diminution in revenue on the project caused by a delay or suspension event for which the employer is responsible.

Because head office overhead costs are typically not allocated to projects, the approach to quantification is not as straightforward as with other delay-related costs, such as the assessment of on-site running costs. Consequently, contractors typically rely on formula-driven assessments to quantify their losses.

There are several formulae that are often referred to that have gained judicial support, including Hudson,[5] Eichleay[6] and Emden.[7] Although the formulae may vary, they mostly seek to identify the head office cost that was to be absorbed by the project during the planned or actual project period, which is multiplied by the period of employer-caused delay.

Distinct from the Emden and Eichleay formulae, the Hudson formula proposed the application of a head office overhead percentage derived from the contractor’s tender as opposed to being based on accounting records. When using this formula, the contractor will often face the argument that the tender percentage bears no relationship to the actual head office cost of the business. This would require the contractor to demonstrate the reasonableness of the tender percentage to justify its use when quantifying its unabsorbed head office overheads.

However, more recently, the approach of using a head office overhead percentage derived from the contractor’s tender has softened. In the 13th edition of Hudson’s Building and Engineering Contracts, it was suggested that the ‘head office overheads and profit percentage applied to the Hudson formula were originally those deducible from the Contractor’s tender. A more modern assumption is to use the head office and profit contribution deducible from the Contractor’s annual accounts, sometimes referred to as “a fair annual average”’.[8] This trend has continued in the latest edition of Hudson.[9] Should the originally suggested tender percentage for head office overheads be substituted with a fair annual average derived from the annual accounts, then a contractor’s quantification using either the Hudson or Emden formulae would be the same.[10] It is also noteworthy that the modified Eichleay formula, in which the head office overhead is allocated to the original contract period instead of the actual contract period, is also tantamount to Emden.

Some practitioners have suggested that an alternative approach is simply to apply an uplift factor to the quantified prolongation costs. Although this approach benefits from its simplicity, it has been rejected by a number of courts and tribunals for being speculative, on the ground that the ratio of one set of costs to another may not be commensurate[11] (i.e., the prolongation costs may bear little or no relation to the allocation of head office overheads to the project).

Head office overhead claims have been the subject of extensive review by courts and tribunals. Although a formula may provide a reasonable basis for quantifying the loss, to establish the loss as a matter of fact, the contractor may be required to:

  • establish that it suffered substantial delay for which it was not responsible;
  • show that a loss has been suffered and that the head office overhead cost was not absorbed through the performance of additional work (e.g., variation orders); and
  • demonstrate that it turned down revenue-generating opportunities that it had a good chance of securing that would have positively contributed to the absorption of head office overheads.

Alternative situations may give rise to claims for dedicated, additional or thickened head office overheads.

Dedicated head office overheads are those resources that can be ascribed to a specific project. These overhead costs would more naturally sit within the contractor’s prolongation claim and may include the cost of personnel who, despite not being on site, were dedicated to the project. It should be possible for a contractor to substantiate these costs with time sheets and other contemporaneous records.

A contractor may claim additional head office overhead costs during a period of extended performance arising from the instruction of additional work. However, the use of a formula may be considered as an inappropriate means of quantifying the loss if the contractor is generating additional project revenue through the completion of additional work that would contribute to its head office overhead costs during the period of extended performance. Therefore, the application of an uplift factor would more accurately quantify the damage.[12]

The concept of thickened head office overheads was considered in a 2018 judgment by the High Court of England and Wales. In this case, the judge gave an example in which an accountant who was part of the head office resource and was not project responsible was consumed by the breach of contract that arose on a specific contract, necessitating the employment of a further accountant to deal with the balance of his work. The judge considered that this would be a direct consequence of the breach and would be a recoverable head of damages.[13]

Termination costs

Termination-related damages can be wide-ranging and include the contractor’s losses for repatriating staff or ending contracts early. Conversely, following the dismissal of a contractor, the employer may enter into a replacement contract and seek to recover the residual cost of completing the remaining scope of work (the employer’s cost to complete damages).

Simply put, the employer’s cost to compete damages is the difference between the value of the dismissed contractor’s outstanding work and the amount paid to the replacement contractor to perform the same. However, in international construction arbitration, the quantification is rarely so straightforward. It is not uncommon for the employer to engage its replacement contractor on different terms and require it to perform additional or enhanced work, preventing a like-for-like comparison between the contractors’ prices.

The argument then turns to one of quantification and, in particular, whether a ‘bottom-up’ or ‘top-down’ approach should prevail. In a top-down approach, the actual cost of the replacement contractor is the starting point for the employer’s damages calculation, which is adjusted to remove amounts that do not pertain to the residual scope of work. However, if this approach is to prevail, it is incumbent on the employer to ensure that the amount claimed is attributable to the dismissal and that it does not contain items of cost that are not.

The starting point for a bottom-up analysis is the itemised residual scope. This would ideally be assessed with reference to the replacement contractor’s rates and prices. In the absence of detailed rates and prices, an assessment based on rates and prices from the terminated contract or analogous rates from other projects may be appropriate, assuming a reasonable adjustment to those rates has been made to account for, among other things, project conditions, price rises and learning curves.

Conclusion

Construction disputes are regularly heard before international arbitral tribunals and although the types of damages claimed and the approach to quantification will often differ, damages associated with delay and disruption, head office overhead costs and termination losses are common, and the path to quantification well-trodden. In this regard, construction damages quantified discretely with a causal nexus between the event and the damage are likely to be more persuasive than cumulative assessments.

The approach to quantifying a party’s loss will depend on the facts of the case, but a fundamental tenet in the quantification of construction disputes is the necessity for contemporaneous records and substantiation to prove the damages.


Notes

[1] Conrad Bromley and Terry Hawkins are managing directors at Secretariat.

[2] Keating on Construction Contracts (11th ed. 2021), Paragraph 8-065.

[3] Society of Construction Law (SCL), Delay and Disruption Protocol (2nd edition, 2017).

[4] ‘Change Orders, Productivity, Overtime – A Primer for the Construction Industry’ was first produced in 1971 by the Mechanical Contractors Association of America, Inc.

[5] See Ian Duncan Wallace, Hudson’s Building and Engineering Contracts (10th ed., Sweet & Maxwell, 1970), p. 599.

[6] See Eichleay Corporation, ASBCA No. 5183, 60-2 BCA (CCH), Paragraph 2688 (1960).

[7] See Alfred McAlpine Homes North Ltd v. Property & Land Contractors Ltd, 76 BLR 59 (1995), which considered, inter alia, the application of the Emden formula.

[8] R Clay and N Dennys, Hudson’s Building and Engineering Contracts (13th ed., Sweet & Maxwell, 2015). p. 801, footnote 480.

[9] R Clay and N Dennys, Hudson’s Building and Engineering Contracts (14th ed., Sweet & Maxwell, 2020), Paragraph 6-071 and footnote 494.

[10] R Champion, ‘The Hudson formula: Death by Footnote?’, Society of Construction Law (2021), p. 6.

[11] Fluor Ltd v. Shanghai Zhenhua Heavy Industry Co, Ltd [2018] EWHC 490 (TCC).

[12] C.B.C. Enterprises, Inc., Plaintiff-Appellant v. The United States, 978 F.2d 669 (Fed. Cir. 1992).

[13] Fluor Ltd v. Shanghai Zhenhua Heavy Industry Co, Ltd [2018] EWHC 490 (TCC).

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